Congress originally designed the Alternative Minimum Tax (AMT) to make sure wealthy taxpayers who take advantage of multiple tax breaks and itemized deductions would still pay their fair share in federal income taxes each year. The AMT produces around $60 billion a year in federal taxes from the top one percent of taxpayers. However, because the AMT wasn’t tied to inflation, the tax has extended down to a growing number of middle-income taxpayers. Here’s what to do about it.
It’s called the Alternative Minimum Tax because it is a mandatory alternative to the standard income tax. If you are a high-income earner, you are required to calculate your taxes twice – once under standard tax rules and again under the stricter AMT rules (the AMT disallows many deductions, such as state and local tax, childcare credits, and property taxes). Ultimately, you are required to pay the higher amount.
Are You at Risk?
First, be aware of the triggers for AMT, as earning a higher income isn’t the only factor. For example, it can also affect those who are married and file jointly, have a large family (more than four dependents), enjoy profits from stock options, or live in a high-tax state. Therefore, any move that reduces your adjusted gross income (AGI) – like upping your contributions to qualified retirement accounts such as IRAs, 401(k)s, and health savings accounts – might help avoid the AMT. Additionally, aim to reduce your itemized deductions and increase your charitable contributions. Finally, pay attention to long-term capital gains – when you sell a home or other investments for a profit. These are taxed at the same rate under both the standard income tax and the AMT, but capital gains could put you over the threshold for AMT, thereby triggering it and disqualifying you from deducting state income taxes paid on the capital gains.
If you practice careful year-round preparation while being mindful of the above triggers, you’ll have a better chance of avoiding the AMT.